Analysis: Amazon bulks up subscriber program to compete

A worker carries packages for shipment at the Amazon warehouse in Leipzig, December 3, 2008.

SAN FRANCISCO (Reuters) - Amazon.com Inc (AMZN.O) has quietly beefed up its free subscription program that delivers bulk goods like packaged food and cleaning supplies, striking a preemptive blow at dominant warehouse retailers Costco (COST.O) and Sam's Club (WMT.N) in a bid to tap into a new wave of repeat customers.

For now, Subscribe & Save could be taking a bite out of the world's largest online retailer's historically thin margins due to the high cost of shipping heavy items. But analysts say the company is willing to take a sort-term hit, banking that convenience and habit will sway customers to spend more down the line.

Diapers, dog food and detergent may not be sexy, but more U.S. retailers are paying attention to such prosaic items.

Long the focus of Wal-Mart Stores Inc, and warehouse club operators like Wal-Mart's Sam's Club, Costco and BJ's Wholesale BJ.N, a host of online sellers in addition to Amazon are trying to woo customers who are tired of trips to the mall and lugging heavy purchases.

When Amazon launched its Subscribe & Save program in 2007, 2,000 items were available for purchase in the service, where users get a 15 percent discount, free two-day shipping and an extra discount on their first order. Three years later it offers more than 25,000 items -- about 30 percent of the products on its website.

Although Amazon says the service appeals to everyone, and is especially popular with moms, analysts see the young urban customer as more viable long-term. As spending from the baby boomer generation begins to wane, a new wave of consumers brought up on the Internet will choose how to best stock up on bulk goods for their families.

"What (Amazon is) trying to do is drive that habit change in the Generation Y shoppers so they see this as the new normal," said Stephen Mader, an analyst with Kantar Retail.

That means the days of loading the family into the car for a "destination" shopping trip may be numbered.

"The Saturday family trip to Costco is an event and we make it fun, but I don't know if it's truly compelling versus taking the kids to the park," said Eric Best, CEO of Mercent, a company founded by Amazon veterans to help retailers sell their wares on various online shopping venues.

"If this is truly a compelling offering from Amazon, dollar for dollar, I think it stands to change the way consumers shop," Best said.

In its most recent second quarter, Amazon reported a 41 percent rise in revenue to $6.6 billion, compared to a nearly 3 percent rise at Wal-Mart to $103.7 billion.

The U.S. research firm Customer Growth Partners blamed Wal-Mart's recent sales weakness on its "inability to respond to the changing nature of American shopping missions" in a recent report

"Walmart's U.S. stores are simply not designed for either the convenience or opportunistic shopping mission," wrote CGP President Craig Johnson.

Still, brick-and-mortar retailers that sell food, dry items and a wide variety of goods from toys to car parts have the advantage of "one-stop shopping," said Wall Street Strategies analyst Brian Sozzi.

"You're not buying a piece of steak on Amazon," said Sozzi, calling a trip to Wal-Mart "instant gratification."

HEAVY AND CHEAP

The economics of shipping detergent across the country for free may seem foolhardy, especially for a company whose operating margin averaged 4.61 percent for 2009. Amazon's vice president of consumables, Doug Herrington, acknowledged that operations and logistics for bulk items could be "challenging."

"When we first started, there were cases where we'd sell a single tube of toothpaste for $2 and we could see that the economics of putting it in a box and shipping it to your house didn't make sense," he said. "But we found that a three-pack did make sense."

Diapers.com co-founder and CEO Marc Lore said the challenge for online retailers is to nudge customers into filling up their boxes so that items shipped at a loss find a counterweight in a higher-margin item.

"The additional weight is negligible," said Lore. "It doesn't cost that much to ship Tide (detergent) if it's the fifth product in the box."

As analyst Sozzi said: "The main thing is to sell the diapers and make the website compelling enough so they look at a Tory Burch handbag too. And maybe get them to buy a Kindle."

Also, the subscription service holds some hidden benefits that can help counter some of the margin-eroding negatives.

Knowing in advance when orders need to be filled helps Amazon streamline operations by ordering more efficiently from manufacturers and getting product to the right distribution centers.

The consumer data also helps the company targeted marketing pushes to spur more sales and cement loyalty. Last week Amazon announced a new subscription program called "Amazon Mom" targeting products for newborns and their busy parents.

Amazon's largest subscription program, Amazon Prime, was once criticized by analysts as margin-draining, as users pay $79 for a year's worth of free shipping. But now it's seen as a strategy coup that encourages users to buy more products across a wider variety of products.

Unlike Amazon Prime, the company appears not to be pushing Subscribe & Save heavily, leading some, like Mercent's Best, to believe Amazon is still in "data gathering mode.

"It's in its infancy. They're putting out feelers," said Sozzi. "Does it drive more traffic and is there a halo effect with other categories?"

(Reporting by Alexandria Sage, editing by Leslie Gevirtz)